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NETSUITE INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis is intended to provide greater details of our results of operations and financial condition and should be read in conjunction with our condensed consolidated financial statements and the notes thereto included elsewhere in this document and the discussion contained in our Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the SEC on February 28, 2012. Certain statements in this Quarterly Report constitute forward-looking statements and as such, involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Such forward-looking statements include any expectation of earnings, revenues or other financial items; any statements of the plans, strategies and objectives of management for future operations; factors that may affect our operating results; statements concerning new products or services; statements related to adding employees; statements related to future capital expenditures; statements related to future economic conditions or performance; statements related to the integration of acquired companies; statements as to industry trends and other matters that do not relate strictly to historical facts or statements of assumptions underlying any of the foregoing. These statements are often identified by the use of words such as "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," or "will," and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to those discussed in the section titled "Risk Factors" included in Item 1A of Part II of this Quarterly Report on Form 10-Q, and the risks discussed in our other SEC filings. We urge you to consider these factors carefully in evaluating the forward-looking statements contained in this Quarterly Report on Form 10-Q. These statements are based on the beliefs and assumptions of our management based on information currently available to management. The forward-looking statements included in this Quarterly Report are made only as of the date of this Quarterly Report. All subsequent written or oral forward-looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. We do not undertake, and specifically disclaim, any obligation to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements except as required by law. Overview We are the industry's leading provider of cloud-based financials/ERP software suites. In addition to financials/ERP software suites, we offer a broad suite of applications, including accounting, CRM, PSA and Ecommerce that enable companies to manage most of their core business operations in our single integrated suite. Our "real-time dashboard" technology provides an easy-to-use view into up-to-date, role-specific business information. We also offer customer support and professional services related to supporting and implementing our suite of applications. We deliver our suite over the Internet as a subscription service using the software-as-a-service ("SaaS") model. In 1999, we released our first application, NetLedger, focused on accounting applications. We then released Ecommerce functionality in 2000 and CRM and sales force automation functionality in 2001. In 2002, we released our next generation suite under the name NetSuite, and we have regularly added features and functionality. In 2008, we acquired OpenAir and in 2009 we acquired QuickArrow, both of which offer professional services automation and project portfolio management products. Our headquarters are located in San Mateo, California. We were incorporated in California in September 1998 and reincorporated in Delaware in November 2007. We conduct our business worldwide, with international locations in Canada, Europe, Asia, South America and Australia. During the second quarter of 2012, we completed the purchase all of the outstanding equity of two small South American companies ("SAC") that specialize in ecommerce technology and services. We also purchased certain assets from two entities related to the SAC. The SAC workforce will augment our existing professional services and product development teams. On the closing dates, we paid $4.0 million in cash. Additional consideration of $2.2 million in cash is being withheld for various periods up to the next 10 years following the close of the transaction as protection against certain losses we may incur in the event of certain breaches of representations and warranties covered in the purchase agreement. During the second quarter of 2012, we recorded $736,000 in operating expenses related to transaction costs associated with this business combination. 14-------------------------------------------------------------------------------- Table of Contents Key Components of Our Results of Operations Revenue Our revenue has grown from $17.7 million during the year ended December 31, 2004 to $236.3 million during the year ended December 31, 2011. We generate sales directly through our sales team and, to a lesser extent, indirectly through channel partners. We sell our service to customers across a broad spectrum of industries, and we have tailored our service for wholesalers/distributors, manufacturers, e-tailers, services companies and software companies. The primary target customers for our service are medium-sized businesses and divisions of large companies. An increasing percentage of our customers and our revenue have been derived from larger businesses within this market. For the six months ended June 30, 2012, we did not have any single customer that accounted for more than 3% of our revenue. We are pursuing a number of strategies that we believe will enable us to continue to grow. The goals of those strategic objectives are to continue to move up-market; to increase use of NetSuite as a platform; and to extend the verticalization of our product line. Although we have made progress towards our goals in recent periods, there are still many areas where we believe that we can continue to grow. To achieve these goals, we are focused on the following initiatives: • Growth of sales of OneWorld, our platform for ERP, CRM and Ecommerce capabilities in multi-currency environments across multiple subsidiaries and legal entities, which supports the needs of large, standalone companies, and divisions of very large enterprises; • Strengthening our offerings for targeted industries such as wholesale/distribution, manufacturing, e-tail, retail, technology and professional services by adding deeper verticalized functionality; and • Developing our SuiteCloud ecosystem to enable third parties to extend our offerings with their vertical expertise or horizontal solution. We experience competitive pricing pressure when our products are compared with solutions that address a narrower range of customer needs or are not fully integrated (for example, when compared with Ecommerce or CRM stand-alone solutions). In addition, since we sell primarily to medium-sized businesses, we also face pricing pressure in terms of the more limited financial resources or budgetary constraints of many of our target customers. We do not currently experience significant pricing pressure from competitors that offer a similar on-demand, integrated business management suite. We sell our application suite pursuant to subscription agreements. The duration of these agreements is generally one year. We rely in part on a large percentage of our customers to renew their agreements to drive our revenue growth. Our customers have no obligation to renew their subscriptions after the expiration of their subscription period. Our subscription agreements provide service level commitments of 99.5% uptime per period, excluding scheduled maintenance. The failure to meet this level of service availability may require us to credit qualifying customers up to the value of an entire month of their subscription and support fees. In light of our historical experience with meeting our service level commitments, we have not accrued any liabilities on our balance sheet for these commitments. We generally invoice our customers in advance in annual or quarterly installments, and typical payment terms provide that our clients pay us within 30 to 60 days of invoice. Amounts that have been invoiced where the customer has a legal obligation to pay are recorded in accounts receivable and deferred revenue. As of June 30, 2012, we had deferred revenue of $130.0 million. During the second quarter of 2012, we updated the terms of our standard renewal agreement form so that the legal obligation to pay by our customers occurs upon execution of the renewal agreement rather than on their renewal date. Based on our existing policy of recording amounts that have been invoiced in accounts receivable and deferred revenue where the customer has a legal obligation to pay, invoices from these renewal agreements are now recorded in accounts receivable and deferred revenue upon execution of the renewal agreement rather than at the start of the renewal period. Had we not revised the terms of these renewal agreements, we would have recorded approximately $5.4 million less in accounts receivable and deferred revenue as of June 30, 2012. 15-------------------------------------------------------------------------------- Table of Contents As part of our overall growth, we expect the percentage of our revenue generated outside of the United States to increase as we invest in and enter new markets. Revenue by geographic region, based on the billing address of the customer, was as follows for the periods presented: Six Months Ended June 30, Three Months Ended June 30, 2012 2011 2012 2011 (dollars in thousands) United States $ 105,940 $ 80,821 $ 55,011 $ 42,350 International 38,088 30,453 19,698 15,483 Total revenue $ 144,028 $ 111,274 $ 74,709 $ 57,833 Percentage of revenue generated outside of the United States 26 % 27 % 26 % 27 % Employees The number of full-time employees as of June 30, 2012 was 1,487 as compared to 1,265 at December 31, 2011 and 1,171 at June 30, 2011. As of June 30, 2012, our headcount included 440 employees in sales and marketing; 603 employees in operations; professional services, training and customer support; 295 employees in product development; and 149 employees in a general and administrative capacity. Cost of Revenue Subscription and support cost of revenue primarily consists of costs related to hosting our application suite, providing customer support, data communications expenses, personnel and related costs of operations, stock-based compensation, software license fees, outsourced subscription services, costs associated with website development activities, allocated overhead, amortization expense associated with capitalized internal use software and acquired developed technology, and related plant and equipment depreciation and amortization expenses. Professional services and other cost of revenue primarily consists of personnel and related costs for our professional services employees and executives, external consultants, stock-based compensation and allocated overhead. We allocate overhead such as rent, information technology costs, employee benefit costs and recruiting costs to all departments based on headcount. As such, general overhead expenses are reflected in cost of revenue and each operating expense category. We expect cost of revenue to remain flat as a percentage of revenue over the near term; however, it could fluctuate period to period depending on the growth of our professional services business and any associated increased costs relating to the delivery of professional services and the timing of significant expenditures. Operating Expenses - Product Development Product development expenses primarily consist of personnel and related costs for our product development employees and executives, including salaries, stock-based compensation, employee benefits and allocated overhead. Our product development efforts have been devoted primarily to increasing the functionality and enhancing the ease of use of our on-demand application suite, as well as localizing our product for international use. A key component of our strategy is to expand our business internationally. This will require us to conform our application suite to comply with local regulations and languages, causing us to incur additional expenses related to translation and localization of our application for use in other countries. At our product development facility in the Czech Republic, we participate in a government program that subsidizes us for employing local residents. Under the program, the Czech government will reimburse us for certain operating expenses we incur. During the first six months of 2012, we reduced our product development expense for eligible operational expenses we 16-------------------------------------------------------------------------------- Table of Contents expect the Czech government to reimburse. On a quarterly basis, we will accrue our expected subsidies for the duration of the program. We expect product development expenses to increase in absolute dollars and increase slightly as a percentage of revenue as we continue to extend our service offerings internationally and as we expand and enhance our application suite technologies. Such expenses may vary due to the timing of these offerings and technologies. Operating Expenses - Sales and Marketing Sales and marketing expenses primarily consist of personnel and related costs for our sales and marketing employees and executives, including wages, benefits, bonuses, commissions and training, stock-based compensation, commissions paid to our channel partners, the cost of marketing programs such as on-line lead generation, promotional events, webinars and other meeting costs, amortization of intangible assets related to trade name and customer relationships and allocated overhead. We market and sell our application suite worldwide through our direct sales organization and indirect distribution channels such as strategic resellers. We capitalize and amortize our direct and channel sales commissions over the period the related revenue is recognized. We believe we have sufficient sales and marketing staff to meet our revenue goals for the remainder of 2012. We expect to continue to invest in sales and marketing to pursue new customers and expand relationships with existing customers. As such, we expect our sales and marketing expenses to increase in terms of absolute dollars and increase slightly as a percentage of total revenue for the remainder of 2012. Operating Expenses - General and Administrative General and administrative expenses primarily consist of personnel and related costs for executive, finance, human resources and administrative personnel, stock-based compensation, legal and other professional fees, other corporate expenses and allocated overhead. We expect our general and administrative expenses to increase in terms of absolute dollars and remain constant as a percentage of total revenue for the remainder of 2012. Income Taxes Since inception, we have incurred annual operating losses and, accordingly, have not recorded a provision for income taxes for any of the periods presented other than provisions for state and foreign income taxes. Critical Accounting Policies and Judgments Our condensed consolidated financial statements are prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances changes in the accounting estimates are reasonably likely to occur from period-to-period. Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management's judgment in its application, while in other cases, significant judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions. We consider these policies requiring significant management judgment to be critical accounting policies. These critical accounting policies are: • Revenue recognition; • Internal use software and website development costs; • Deferred commissions; • Accounting for stock-based compensation; and • Goodwill and other intangible assets 17-------------------------------------------------------------------------------- Table of Contents There have been no significant changes in our critical accounting policies and estimates during the six months ended June 30, 2012 as compared to the critical accounting policies and estimates disclosed in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Judgments" included in our Annual Report on Form 10-K for the year ended December 31, 2011 filed on February 28, 2012. In addition, please see Note 2 of Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q and Note 2 of the Notes to Consolidated Financial Statements included in our 2011 Annual Report on Form 10-K filed on February 28, 2012 for a description of our accounting policies. Results of Operations Revenue, Cost of Revenue and Gross Margin Information about revenue, cost of revenue, gross profit and gross margin was as follows for the periods presented: Six Months Ended June 30, Three Months Ended June 30, 2012 2011 2012 2011 (dollars in thousands) Revenue: Subscription and support $ 119,039 $ 94,054 $ 61,049 $ 48,240 Professional services and other 24,989 17,220 13,660 9,593 Total revenue 144,028 111,274 74,709 57,833 Cost of revenue (1): Subscription and support 19,842 15,715 10,631 8,084 Professional services and other 24,007 17,792 12,423 9,390 Total cost of revenue 43,849 33,507 23,054 17,474 Gross profit $ 100,179 $ 77,767 $ 51,655 $ 40,359 Gross margin 70 % 70 % 69 % 70 % (1) Includes stock-based compensation expense and amortization of intangible assets of: Cost of revenue: Subscription and support $ 2,388 $ 1,891 $ 1,484 $ 919 Professional services and other 2,677 1,988 1,504 1,024 $ 5,065 $ 3,879 $ 2,988 $ 1,943 Six Months Ended June 30, 2012 as Compared to the Six Months Ended June 30, 2011 Revenue for the six months ended June 30, 2012 increased $32.8 million, or 29%, compared to the same period in 2011. Subscription and support revenue: Subscription and support revenue for the six months ended June 30, 2012 increased $25.0 million, or 27%, compared to the same period in 2011. The increase was primarily the result of a $20.5 million increase in revenue resulting from the acquisition of new customers, the continued adoption of OneWorld and a $4.5 million increase in revenue from existing customers. Professional services and other revenue: Professional services and other revenue for the six months ended June 30, 2012 increased $7.8 million, or 45%, compared to the same period in 2011. The increase was primarily the result of a $16.1 million increase in revenue resulting from the acquisition of new customers and an increase in productivity. As we move up market to larger customers, the scope of our professional services engagements have increased resulting in an increase in demand for our professional services. The increase in professional services and other revenue was partially offset by an $8.4 million decrease in revenue from existing customers related to services purchased in connection with the initial implementation of our product in 2011 that did not recur for those customers in 2012. 18-------------------------------------------------------------------------------- Table of Contents Revenue generated outside of the United States was $38.1 million, or 26%, of our total revenue for the six months ended June 30, 2012 as compared to $30.5 million, or 27%, for the same period in 2011. Revenue generated outside of the United States increased primarily due to an increase in our sales efforts internationally, particularly in Australia. Cost of revenue for the six months ended June 30, 2012 increased $10.3 million, or 31%, compared to the same period in 2011. Subscription and support cost of revenue: Subscription and support cost of revenue for the six months ended June 30, 2012 increased $4.1 million, or 26%, compared to the same period in 2011. The increase was primarily due to a $2.1 million increase in personnel costs resulting from an increase in headcount and annual salary increases. Additionally, data center and other costs increased by $2.0 million due to an increase in vendor prices, an increase in support costs, an increase in depreciation and an increase in other operational costs associated with an increase in our data center capacity and activity. In the second quarter of 2012, we also recorded a $401,000 impairment charge related to the acquired QA developed technology intangible asset because the legacy customers migrated to another NetSuite product or terminated their service completely. Professional services and other cost of revenue: Professional services and other cost of revenue for the six months ended June 30, 2012 increased $6.2 million, or 35%, compared to the same period in 2011. The increase was primarily the result of a $3.5 million increase in personnel costs, a $1.4 million increase in fees related to outsourced consulting services and a $1.2 million increase in overhead expense allocations. Personnel costs increased due to an increase in headcount, annual merit increases and incentive bonuses. Outsourced consulting fees increased due to an increase in demand for our professional services. Overhead expense allocations increased due to higher overhead costs. Our gross margin remained constant at 70% during the six months ended June 30, 2012 compared to the same period in 2011. Our professional services, which has a lower gross margin than subscription and support services, represented a larger portion of total revenue during the first six months of 2012 when compared to the same period in 2011, so our increase in total revenue did not increase gross margin. Three Months Ended June 30, 2012 as Compared to the Three Months Ended June 30, 2011 Revenue for the three months ended June 30, 2012 increased $16.9 million or 29% compared to the same period in 2011. Subscription and support revenue: Subscription and support revenue for the three months ended June 30, 2012 increased $12.8 million, or 27%, compared to the same period in 2011. The increase was primarily the result of a $10.8 million increase in revenue resulting from the acquisition of new customers, the continued adoption of OneWorld and a $2.0 million increase in revenue from existing customers. Professional services and other revenue: Professional services and other revenue for the three months ended June 30, 2012 increased $4.1 million, or 42%, compared to the same period in 2011. The increase was primarily the result of a $9.0 million increase in revenue resulting from the acquisition of new customers and an increase in productivity. As we move up market to larger customers, the scope of our professional services engagements have increased resulting in an increase in demand for our professional services. The increase in professional services and other revenue was partially offset by a $4.9 million decrease in revenue from existing customers related to services purchased in connection with the initial implementation of our product in 2011 that did not recur for those customers in 2012. Revenue generated outside of the United States was $19.7 million, or 26%, of our total revenue for the three months ended June 30, 2012 as compared to $15.5 million, or 27%, for the same period in 2011. Revenue generated outside of the United States increased primarily due to an increase in our sales efforts internationally, particularly in Australia. Cost of revenue for the three months ended June 30, 2012 increased $5.6 million, or 32%, compared to the same period in 2011. Subscription and support cost of revenue: Subscription and support cost of revenue for the three months ended June 30, 2012 increased $2.5 million, or 32%, compared to the same period in 2011. The increase was primarily due to a $1.2 million increase in personnel costs resulting from an increase in headcount and annual salary increases. Additionally, data center and other costs increased by $1.0 million due to an increase in vendor prices, an increase in support costs, an increase in 19-------------------------------------------------------------------------------- Table of Contents depreciation and an increase in other operational costs associated with an increase in our data center capacity and activity. In the second quarter of 2012, we also recorded a $401,000 impairment charge related to the acquired QA developed technology intangible asset because the legacy customers migrated to another NetSuite product or terminated their service completely. Professional services and other cost of revenue: Professional services and other cost of revenue for the three months ended June 30, 2012 increased $3.0 million, or 32%, compared to the same period in 2011. The increase was primarily the result of a $1.7 million increase in personnel costs, a $617,000 increase in fees related to outsourced consulting services and a $709,000 increase in overhead expense allocations. Personnel costs increased due to an increase in headcount, annual merit increases and incentive bonuses. Outsourced consulting fees increased due to an increase in demand for our professional services. Overhead expense allocations increased due to higher overhead costs. Our gross margin decreased slightly to 69% during the three months ended June 30, 2012 compared to the same period in 2011. During the second quarter of 2012, our gross margin was negatively affected by higher subscription revenue costs particularly a $401,000 impairment charge related to the acquired QA developed technology intangible asset because the legacy customers migrated to another NetSuite product or terminated their service completely. Operating Expenses Operating expenses were as follows for the periods presented: Six Months Ended June 30, 2012 2011 Amount % of revenue Amount % of revenue (dollars in thousands) Operating expenses (1): Product development $ 24,368 17 % $ 20,358 18 % Sales and marketing 73,140 51 % 57,930 52 % General and administrative 18,876 13 % 16,217 15 % Total operating expenses $ 116,384 81 % $ 94,505 85 % Three Months Ended June 30, 2012 2011 Amount % of revenue Amount % of revenue (dollars in thousands) Operating expenses (1): Product development $ 13,277 18 % $ 10,911 19 % Sales and marketing 37,561 50 % 30,469 53 % General and administrative 9,897 13 % 8,340 14 % Total operating expenses $ 60,735 81 % $ 49,720 86 % (1) Includes stock-based compensation expense, amortization of acquisition-related intangible assets and transaction costs for business combinations as follows: Six Months Ended June 30, Three Months Ended June 30, 2012 2011 2012 2011 (dollars in thousands) Product development $ 7,267 $ 5,277 $ 4,060 $ 3,097 Sales and marketing 8,162 6,507 4,204 3,422 General and administrative 5,969 5,319 3,415 2,956 Total $ 21,398 $ 17,103 $ 11,679 $ 9,475 20-------------------------------------------------------------------------------- Table of Contents Six Months Ended June 30, 2012 as Compared to the Six Months Ended June 30, 2011 Product development expenses for the six months ended June 30, 2012 increased $4.0 million, or 20%, as compared to the same period in 2011. The increase was primarily the result of a $4.4 million increase in personnel costs resulting from an increase in headcount, annual salary increases, payroll tax increases and an increase in stock-based compensation. The increase in personnel costs includes a $2.0 million increase in stock-based compensation resulting primarily from the issuance of annual equity awards to employees. Additionally, overhead expense allocations and other costs increased by $1.1 million due to higher overhead costs and an increase in product development headcount. These cost increases were partially offset by expense reductions related to a $979,000 employment development subsidy from the Czech Republic government for the period of November 2010 to June 30, 2012 and a $533,000 increase in capitalized product development costs associated with new product functionality. Sales and marketing expenses for the six months ended June 30, 2012 increased $15.2 million, or 26%, as compared to the same period in 2011. The increase was primarily the result of an $11.8 million increase in personnel costs, a $1.9 million increase in marketing expenses and a $979,000 increase in overhead expense allocations and other operating expenses, net. The increase in personnel costs related primarily to increases in commission and payroll expenses resulting from higher sales and an increase in headcount. Additionally, personnel costs include a $1.6 million increase in stock-based compensation resulting primarily from the issuance of annual equity awards. Marketing expenses also increased by $1.9 million primarily due to a $1.3 million increase in on-line and corporate marketing expenses and $638,000 in costs associated with our annual user conference and other promotional events. Overhead allocation and other operating expenses, net increased due to an increase in overhead costs allocations. General and administrative expenses for the six months ended June 30, 2012 increased $2.7 million, or 16%, as compared to the same period in 2011. The increase was primarily the result of a $3.4 million increase in personnel costs, a $1.3 million increase in other operational costs, an $842,000 increase in overhead costs and a $736,000 increase in acquisition transaction costs, partially offset by $2.7 million in overhead expense cost allocations to other departments and a $720,000 decrease in patents expenses. The increase in personnel costs resulted from an increase in headcount, an increase in merit pay and an increase in other payroll costs such as recruiting. Other operational costs increased primarily due to an increase in costs related to general administrative services and $430,000 in additional sales taxes. Overhead costs increased primarily due to an increase in facility costs at various locations. During the second quarter of 2012, we incurred $736,000 in transaction costs in connection with our acquisition of SAC. Our overhead expense allocations increased due to an increase in costs allocated. Our patent costs decreased due to a $720,000 patent settlement expense recorded in 2011, but not incurred in 2012. Three Months Ended June 30, 2012 as Compared to the Three Months Ended June 30, 2011 Product development expenses for the three months ended June 30, 2012 increased $2.4 million, or 22%, as compared to the same period in 2011. The increase was primarily the result of a $2.5 million increase in personnel costs resulting from an increase in headcount, annual salary increases, payroll tax increases and an increase in stock-based compensation. The increase in personnel costs includes a $963,000 increase in stock-based compensation resulting primarily from the issuance of annual equity awards to employees. Additionally, overhead expense allocations increased by $340,000 due to higher overhead costs and an increase in product development headcount. These cost increases were partially offset by expense reductions related to a $262,000 employment development subsidy from the Czech Republic government for the second quarter of 2012 and a $356,000 increase in capitalized product development costs associated with new product functionality. Sales and marketing expenses for the three months ended June 30, 2012 increased $7.1 million, or 23%, as compared to the same period in 2011. The increase was primarily the result of a $5.0 million increase in personnel costs, a $1.3 million increase in marketing expenses and an $814,000 increase in overhead expense allocations and other operating expenses, net. The increase in personnel costs related primarily to increases in commission and payroll expenses resulting from higher sales and an increase in headcount. Additionally, personnel costs include a $722,000 increase in stock-based compensation resulting primarily from the issuance of annual equity awards. Marketing expenses also increased by $1.3 million primarily due to a $591,000 increase in on-line and corporate marketing expenses and $580,000 in costs associated with our annual user conference and other promotional events. Overhead allocation and other operating expenses, net increased due to an increase in overhead costs allocations. 21-------------------------------------------------------------------------------- Table of Contents General and administrative expenses for the three months ended June 30, 2012 increased $1.6 million, or 19%, as compared to the same period in 2011. The increase was primarily the result of a $1.6 million increase in personnel costs, a $845,000 increase in other operational costs, a $736,000 increase in acquisition transaction costs and a $399,000 increase in overhead costs partially offset by $1.3 million in overhead expense cost allocations to other departments and a $720,000 decrease in patents expenses. The increase in personnel costs resulted from an increase in headcount, an increase in merit pay and an increase in other payroll costs such as recruiting. Other operational costs increased primarily due to an increase in costs related to general administrative services and $302,000 in additional sales tax. Overhead costs increased primarily due to an increase in facility costs at various locations. During the second quarter of 2012, we incurred $736,000 in transaction costs in connection with our acquisition of SAC. Our overhead expense allocations increased due to an increase in costs allocated. Our patent costs decreased due a $720,000 patent settlement expense recorded in 2011, but not incurred in 2012. Non-operating Items Non-operating items, including interest income and expense, other expense, net and income taxes were as follows for the periods presented: Six Months Ended June 30, 2012 2011 Amount % of revenue Amount % of revenue (dollars in thousands) Interest income $ 92 - % $ 91 - % Interest expense (103 ) - % (65 ) - % Other expense, net (114 ) - % (16 ) - % Provision for income taxes 1,293 1 % 735 1 % Three Months Ended June 30, 2012 2011 Amount % of revenue Amount % of revenue (dollars in thousands) Interest income $ 42 - % $ 42 - % Interest expense (51 ) - % (33 ) - % Other expense, net (61 ) - % (16 ) - % Provision for income taxes 763 1 % 423 1 % Liquidity and Capital Resources As of June 30, 2012, our primary sources of liquidity were our cash and cash equivalents totaling $164.5 million and our accounts receivable, net of allowance, totaling $44.4 million. In the six months ended June 30, 2012, cash flows from operations were $25.7 million. Although we have had positive operating cash flows for thirteen consecutive quarters, the possibility remains that we could return to a position of negative operating cash flows in a future period. Despite the possibility of such fluctuations in operating cash outflows, management believes its current cash and cash equivalents are sufficient for the next 12 months to meet our operating cash flow needs. We intend to use our cash for general corporate purposes, including potential future acquisitions or other transactions. Further, we expect to incur additional expenses in connection with our international expansion. We believe that our cash and cash equivalents are adequate to fund those anticipated activities. While we believe that our uncommitted current working capital and anticipated cash flows from operations will be 22-------------------------------------------------------------------------------- Table of Contents adequate to meet our cash needs for daily operations and capital expenditures for at least the next 12 months, we may elect to raise additional capital through the sale of additional equity or debt securities, obtain a credit facility or sell certain assets. If additional funds are raised through the issuance of additional debt securities, these securities could have rights, preferences and privileges senior to holders of common stock, and terms of any debt could impose restrictions on our operations. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders and additional financing may not be available in amounts or on terms acceptable to us. As we believe that our cash and cash equivalents are adequate to fund our operating and investing cash flow needs for at least the next 12 months, we have not found it necessary to reassess our capacity to generate cash from financing cash flows in the current economic climate. If additional financing becomes necessary and we are unable to obtain the additional funds, we may be required to reduce the scope of our planned product development and marketing efforts, potentially harming our business, financial condition and operating results. In the meantime, we intend to continue to manage our cash in a manner designed to ensure that we have adequate cash and cash equivalents to fund our operations as well as future acquisitions, if any. Restricted cash consisting of letters of credit for our facility lease agreements is included in long-term other assets and totaled $541,000 as of June 30, 2012 and $495,000 as of December 31, 2011. As of June 30, 2012, we had an accumulated deficit of $361.2 million. We have funded this deficit primarily through the net proceeds raised from the sale of our capital stock and proceeds from operations. A summary of our cash flow activities were as follows for the periods presented: Six Months Ended June 30, 2012 2011 (dollars in thousands) Net cash provided by operating activities $ 25,736 $ 15,142 Net cash used in investing activities (9,732 ) (4,761 ) Net cash provided by financing activities 6,890 6,081 Effect of exchange rate changes on cash and cash equivalents 137 290 Net change in cash and cash equivalents $ 23,031 $ 16,752 Cash provided by operating activities was driven by sales of our application suite offset by costs incurred to deliver that service. The timing of our billings and collections relating to our sales and the timing of the payment of our liabilities have a significant impact on our cash flows. Cash flows from operations increased during the six months ended June 30, 2012 as compared to the same period in 2011 primarily as a result of an increase in revenue and deferred revenue offset by an increase in accounts receivable and commissions paid. Cash used in investing activities during the six months ended June 30, 2012 increased from the same period in 2011 primarily due to a $3.9 million cash payment, net of cash acquired, for the acquisition of SAC in the second quarter of 2012 and a $1.2 million increase in capital expenditures for property and equipment at our data centers in California and Massachusetts. The net cash provided by financing activities for the six months ended June 30, 2012 increased due to proceeds received from employee stock option exercises and the timing of debt payments made to a related party. Off Balance Sheet Arrangements and Contractual Obligations During the six months ended June 30, 2012 and 2011, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off balance sheet arrangements or other contractually narrow or limited purposes. During the first quarter of 2012, we amended our Manila, Philippines office lease agreement to extend the termination date from the May 1, 2012 to April 30, 2015. The three year lease extension also includes additional office space so we can expand our operations in the future. According to the amended lease, we will pay a total of $3.4 million over the extended lease term. 23-------------------------------------------------------------------------------- Table of Contents |